Fear is Making a Comeback

06/25/2013 8:00 am EST

Focus: OPTIONS

Mark Sebastian

Founder, OptionPit.com

The market has had an uptick in volatility lately, and as the VIX closed above 20 on Thursday for the first time this year, Mark Sebastian of OptionPit.com offers some cautionary advice.

As the bond market continues to deteriorate, the SPX managed to hold positive on the day last Friday. This, after a massive sell off and a major spike in the VIX on Thursday. The VIX came in nicely into the weekend along with the small market rally. Intraday, the market had a nice push downward and managed to bounce off the lows. So does this mean that it is now officially safe harbor? Probably not, take a look at a chart of VIX pops and the following days:

chart
LIvevolX® www.livevol.com
Click to Enlarge

Every time the VIX has had a leg up, the indexes has sold off, only to rally higher the next time there is a push. Then add in the fact that almost EVERY time the VIX breaks 20 coming from the sub-15 level, it eases off then rallies again through 20 and to a higher level. We almost expect these types of premium sales into weekends after a big pop and little SPX movement.

I can tell you what the bottom will look like. The SPX is going to sell off 20-30 points, maybe more, and the VIX will completely underperform the movement in the SPX. When the VIX is trading 25, the SPX will be down 25-30 points and the VIX will be up less than two points. If the VIX is above 30 at the time, the VIX might actually be down on the day. It will be even more obvious if that happens on an even bigger down day.

The Trade
We think it makes sense to stay premium neutral waiting to outright sell premium until the market gives a 'fail' signal. There are options that are cheap to buy and options that are really overpriced out there. Be smart, find EDGE.

By Mark Sebastian, Blogger and Contributor, OptionPit.com

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